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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
- -- ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED NOVEMBER 2, 2002,
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- -- EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO ________.
COMMISSION FILE NUMBER 33-66342
COLE NATIONAL GROUP, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 34-1744334
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
5915 LANDERBROOK DRIVE 44124
MAYFIELD HEIGHTS, OHIO (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(440) 449-4100
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a) AND
(b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM IN THE REDUCED DISCLOSURE
FORMAT.
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO
--- ---
ALL OF THE OUTSTANDING CAPITAL STOCK OF THE REGISTRANT IS HELD BY COLE NATIONAL
CORPORATION.
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER
(AS DEFINED IN RULE 12b-2 OF THE EXCHANGE ACT). YES X NO
--- ---
AS OF NOVEMBER 30, 2002, 1,100 SHARES OF THE REGISTRANT'S COMMON STOCK, $.01 PAR
VALUE WERE OUTSTANDING.
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EXPLANATORY NOTE
This Form 10-Q of Cole National Corporation (the "Company") includes
the effects of the restatement described in Note 8 to the accompanying
Consolidated Financial Statements. See Note 8 for a summary of the effects of
the restatement on previously issued financial statements for prior periods.
COLE NATIONAL GROUP, INC. AND SUBSIDIARIES
FORM 10-Q
QUARTER ENDED NOVEMBER 2, 2002
INDEX
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of November 2, 2002 and February 2, 2002
(as restated) ........................................................................... 1
Consolidated Statements of Operations for the 13 and 39 week periods ended
November 2, 2002 and November 3, 2001 (as restated) ...................................... 2
Consolidated Statements of Cash Flows for the 39 week periods ended
November 2, 2002 and November 3, 2001 (as restated) ...................................... 3
Notes to Consolidated Financial Statements ............................................... 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation ....... 14
Item 3. Quantitative and Qualitative Disclosures about Market Risk ................................. 24
Item 4. Controls and Procedures .................................................................... 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ......................................................................... 26
Item 6. Exhibits and Reports on Form 8-K ........................................................... 27
Signatures ......................................................................................... 28
Certifications ..................................................................................... 29
Exhibit Index ...................................................................................... 31
PART I. - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COLE NATIONAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in thousands)
February 2,
2002
November 2, (As restated,
2002 see Note 8)
----------- -------------
Assets
Current assets:
Cash and cash equivalents $ 21,327 $ 63,418
Accounts receivable, less allowances of
$2,559 and $3,228, respectively 48,621 41,299
Current portion of notes receivable 2,756 2,723
Inventories 135,651 119,203
Prepaid expenses and other 27,621 29,013
Deferred income taxes 28,298 27,161
--------- ---------
Total current assets 264,274 282,817
Property and equipment, at cost 314,862 298,918
Less - accumulated depreciation and amortization (193,569) (180,536)
--------- ---------
Total property and equipment, net 121,293 118,382
Notes receivable, excluding current portion, less allowances of
$3,784 and $5,209, respectively 4,087 4,709
Deferred income taxes 26,233 22,156
Other assets 44,892 43,690
Other intangibles, net 46,646 45,996
Goodwill, net 85,550 85,543
--------- ---------
Total assets $ 592,975 $ 603,293
========= =========
Liabilities and Stockholder's Equity
Current liabilities:
Current portion of long-term debt $ 227 $ 229
Accounts payable 66,353 64,863
Payable to affiliate, net 80,013 85,477
Accrued interest 8,164 6,340
Accrued liabilities 85,518 92,324
Accrued income taxes - 373
Deferred revenue 37,592 35,401
--------- ---------
Total current liabilities 277,867 285,007
Long-term debt, net of discount and current portion 276,254 274,574
Other long-term liabilities 19,594 17,919
Deferred revenue, long term 11,559 11,049
Stockholder's equity 7,701 14,744
--------- ---------
Total liabilities and stockholder's equity $ 592,975 $ 603,293
========= =========
The accompanying notes to consolidated financial statements are an integral
part of these consolidated financial statements.
1
COLE NATIONAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands)
Thirteen Week Thirty-Nine Week
Periods Ended Periods Ended
---------------- ------------- ------------------------------
November 3, November 3,
2001 2001
November 2, (As restated, November 2, (As restated,
2002 see Note 8) 2002 see Note 8)
----------- ------------- ----------- -------------
Net revenue $ 275,501 $ 263,349 $ 853,332 $ 810,457
Costs and expenses:
Cost of goods sold 91,948 87,394 278,697 262,600
Operating expenses 183,702 175,635 555,631 527,171
Goodwill and tradename amortization - 1,252 - 3,758
--------- --------- --------- ---------
Total costs and expenses 275,650 264,281 834,328 793,529
--------- --------- --------- ---------
Operating income (loss) (149) (932) 19,004 16,928
Interest and other (income) expense, net:
Interest expense 6,576 7,169 20,399 21,116
Interest and other (income), net (150) (532) (1,125) (2,717)
--------- --------- --------- ---------
Total interest and other (income) expense, net 6,426 6,637 19,274 18,399
--------- --------- --------- ---------
Income (loss) before income taxes (6,575) (7,569) (270) (1,471)
Income tax provision (benefit) (6,777) (8,365) (277) (1,626)
--------- --------- --------- ---------
Income (loss) before extraordinary loss 202 796 7 155
Extraordinary loss on early extinguishment of debt,
net of $3.9 million tax benefit - - (7,242) -
--------- --------- --------- ---------
Net income (loss) $ 202 $ 796 $ (7,235) $ 155
========= ========= ========= =========
The accompanying notes to consolidated financial statements are an integral
part of these consolidated financial statements.
2
COLE NATIONAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
Thirty-Nine Week Periods Ended
-----------------------------
November 3,
2001
November 2, (As restated,
2002 see Note 8)
----------- -------------
Cash flows from operating activities:
Net income (loss) $ (7,235) $ 155
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 26,837 28,699
Extraordinary loss on early extinguishment of debt, net of tax 7,242 -
Noncash interest and other, net 511 1,038
Gain on sale of building - (683)
Increases (decreases) in cash resulting from changes in operating
assets and liabilities:
Accounts and notes receivable, prepaid expenses and other assets (5,433) 5,165
Inventories (16,385) (14,042)
Accounts payable, accrued liabilities and other liabilities 16,380 (11,437)
Accrued interest 1,824 996
Accrued, refundable and deferred income taxes (1,679) (2,623)
--------- ---------
Net cash provided by operating activities 22,062 7,268
--------- ---------
Cash flows from investing activities:
Purchases of property and equipment, net (33,274) (27,256)
Net proceeds from sale of fixed assets - 4,712
Systems development costs (3,671) (5,826)
Acquisition of business, net of cash acquired (978) (100)
Other, net (336) (711)
--------- ---------
Net cash used for investing activities (38,259) (29,181)
--------- ---------
Cash flows from financing activities:
Repayment of long-term debt (158,233) (99)
Proceeds from issuance of long-term debt 150,000 -
Increase (decrease) overdraft balances (6,289) 12,579
Advances to parent, net (5,117) (5,799)
Payment of deferred financing fees (6,208) -
Other, net (47) (93)
--------- ---------
Net cash (used for) provided by financing activities (25,894) 6,588
--------- ---------
Cash and cash equivalents:
Net decrease during the period (42,091) (15,325)
Balance, beginning of period 63,418 37,218
--------- ---------
Balance, end of period $ 21,327 $ 21,893
========= =========
The accompanying notes to consolidated financial statements are an integral
part of these consolidated financial statements.
3
COLE NATIONAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Cole National Group, Inc. is a wholly owned subsidiary of Cole National
Corporation. The consolidated financial statements include the accounts of Cole
National Group and its wholly owned subsidiaries (collectively, the "Company").
All significant intercompany transactions have been eliminated in consolidation.
The accompanying consolidated financial statements have been prepared
without audit and certain information and footnote disclosures normally included
in financial statements prepared in accordance with accounting principles
generally accepted in the United States have been condensed or omitted, although
management believes that the disclosures herein are adequate to make the
information not misleading. Results for interim periods are not necessarily
indicative of the results to be expected for the full year. When reading the
financial information in this quarterly report, reference should be made to the
consolidated financial statements and notes contained in the Company's most
recently filed Annual Report on Form 10-K filed concurrently with this quarterly
report.
Nature of Operations
The Company is a specialty service retailer operating in both host and
nonhost environments, whose primary lines of business are optical products and
services and personalized gifts. The Company sells its products through 2,509
company-owned retail locations and 447 franchised locations in 50 states,
Canada, and the Caribbean. In connection with its optical business, the Company
is a managed vision care benefits provider and claims payment administrator
whose programs provide comprehensive eyecare benefits primarily marketed
directly to large employers, health maintenance organizations (HMO) and other
organizations. The Company has two reportable segments: Cole Vision and Things
Remembered (see Note 5).
Use of Estimates
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States, requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Significant estimates are required in determining the allowance for
uncollectible accounts, inventory valuation, depreciation, amortization and
recoverability of long-lived assets, deferred income taxes, remakes and returns
allowances, managed vision underwriting results, self-insurance reserves, and
retirement and post-employment benefits.
Reclassifications
Certain reclassifications have been made to prior year financial
statements and the notes to conform to the current year presentation.
Revenue Recognition and Deferred Revenue
Revenues include sales of goods and services, including delivery fees
to retail customers at company-operated stores, sales of merchandise inventory
to franchisees and other outside customers, other revenues from franchisees such
as royalties based on sales and initial franchise fees, and capitation and other
fees associated with Cole Vision's managed vision care business.
Revenues from merchandise sales and services, net of estimated returns
and allowances, are recognized at the time of customer receipt or when the
related goods are shipped direct to the customer and all significant obligations
of the Company have been satisfied. The reserve for returns and allowances is
calculated as a percentage of sales based on historical return percentages.
Capitation revenues are accrued when due under related contracts at the agreed
upon per member, per month rates. Administrative service revenue is recognized
when services are provided over the contract period and the Company's customers
are obligated to pay.
4
Additionally, the Company sells discount programs which have twelve-month
terms. Revenues from discount programs are deferred and amortized over the
twelve-month term.
Additionally, the Company sells separately priced extended warranty
contracts with terms of coverage of 12 and 24 months. Revenues from the sale of
these contracts are deferred and amortized over the lives of the contracts while
the costs to service the warranty claims are expensed as incurred. Incremental
costs directly related to the sale of such contracts, such as sales commissions
and percentage rent, are deferred in prepaid expenses and charged to expense in
proportion to the revenue recognized.
Franchise revenues based on sales by franchisees are accrued as earned.
Initial franchise fees are recorded as revenue when all material services or
conditions relating to the sale of the franchises have been substantially
performed or satisfied by the Company and when the related store begins
operations.
Things Remembered sells memberships in its Rewards Club(TM) program,
which allows members to earn rebates based on their accumulated purchases. The
Company defers and amortizes the membership fee revenue over the life of the
membership. The rebates which can only be used to offset the price of future
customer purchases are recognized as a reduction of revenue based on the rebates
earned and the estimated future redemptions. The cumulative liability for
unredeemed rebates is adjusted over time based on actual experience and trends
with respect to redemption.
Valuation of Inventories
Inventories are recorded at the lower of cost or market based on the
first-in, first-out (FIFO) method for the optical inventories and based on the
weighted average cost method for the gift inventories. The Company records a
valuation reserve for future inventory cost markdowns to be taken for inventory
not expensed to be part of its ongoing merchandise offering. The reserve is
estimated based on historical information regarding sell through of similar
products. The Company records a reserve for estimated shrinkage based on various
factors including sales volume, historical shrink results and current trends.
Property and Equipment
Property and equipment are stated at cost. Repairs and maintenance
costs that extend the life of the asset are capitalized. Depreciation is
provided principally by using the straight-line method over the estimated useful
life of the related assets, generally 2 to 10 years for furniture, fixtures and
equipment, 2 to 25 years for leasehold improvements and 5 to 40 years for
buildings and improvements.
Derivatives and Hedging Activity
The interest rate swap agreements utilized by the Company are
designated as fair value hedges of the underlying fixed rate debt obligations
and are recorded at fair value as an increase in noncurrent assets or
liabilities and an increase or decrease in long-term debt. These interest rate
swaps qualify for the short-cut method for assessing hedge effectiveness under
the provisions of Statement of Financial Accounting Standard (SFAS) No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (SFAS 133).
Changes in fair value of the interest rate swaps are offset by the changes in
fair value of the underlying debt.
Goodwill and Other Intangible Assets
Goodwill, non-compete agreements and tradename assets were amortized
over their estimated useful economic life using the straight-line method and are
carried at cost less accumulated amortization. Beginning with fiscal year 2002,
all goodwill and tradename amortization ceased in accordance with Statement of
Financial Accounting Standard (SFAS) No. 142, "Goodwill and Other Intangible
Assets" (SFAS 142); and both goodwill and tradenames are tested at least
annually for impairment. The Company adopted the first day of the fourth fiscal
quarter for the annual impairment review. Other intangible assets with finite
lives are amortized over their estimated useful lives based on management's
estimates of the period that the assets will generate revenue.
5
Cash Flows
Net cash flows from operating activities reflect cash payments for
income taxes and interest of $1,057,000 and $17,730,000, respectively, for the
39 week periods ended November 2, 2002 and $981,000 and $19,218,000,
respectively, for the 39 week periods ended November 3, 2001.
Total Other Comprehensive Income (Loss)
Total other comprehensive income (loss) for the 13 and 39 week periods
ended November 2, 2002 and November 3, 2001 is as follows (000's omitted):
Thirteen Week Periods Thirty-Nine Week Periods
---------------------- ------------------------
2002 2001 2002 2001
------- ------- ------- -------
Net income (loss) $ 202 $ 796 $(7,235) $ 155
Cumulative translation income (loss) 276 (255) 266 (425)
------- ------- ------- -------
Total other comprehensive income (loss) $ 478 $ 541 $(6,969) $ (270)
======= ======= ======= =======
(2) GOODWILL AND OTHER INTANGIBLE ASSETS
The Company adopted SFAS 142 in the first quarter of fiscal 2002. This
statement requires that goodwill and certain intangible assets deemed to have
indefinite lives will no longer be amortized, but instead, be subject to reviews
for impairment annually, or more frequently if certain indicators arise. With
the adoption of this statement, the Company ceased amortization of goodwill and
tradenames as of February 3, 2002.
The Company completed the transitional impairment testing of goodwill
and tradenames during the second quarter of fiscal 2002 as required by SFAS 142.
Based on the findings of its outside valuation advisor, the Company has
concluded that there was no impairment at the adoption date of the new
accounting standard, effective February 3, 2002. The Company has elected to
perform its annual tests for potential impairment as of the first day of the
Company's fourth fiscal quarter.
The following table provides the comparable effects of adopting SFAS
142 for the 13 and 39 week periods ended November 2, 2002 and November 3, 2001.
Thirteen Week Periods Thirty-Nine Week Periods
----------------------- ------------------------
2002 2001 2002 2001
----------------------- ------------------------
(Dollars in thousands)
Net income:
Reported income (loss) $ 202 $ 796 $(7,235) $ 155
Goodwill amortization - Cole Vision - 704 - 2,118
Goodwill amortization - Things Remembered - 238 - 712
Tradename amortization - Cole Vision - 310 - 928
Related tax adjustment - (170) - (510)
--------- --------- -------- ----------
Adjusted net income (loss) $ 202 $ 1,878 $(7,235) $ 3,403
========= ========= ======== ==========
Other intangible assets consist of (dollars in thousands):
2002 2001
----------- ------------
Tradename $ 49,460 $ 49,460
Noncompete agreements 240 240
Contracts 4,438 3,460
----------- ------------
54,138 53,160
Accumulated amortization (7,492) (7,164)
----------- ------------
Other intangibles, net $ 46,646 $ 45,996
=========== ============
6
The net carrying amount of goodwill at November 2, 2002, by business
segment, was $64.2 million at Cole Vision and $21.4 million at Things
Remembered. The increase in the net carrying amount of goodwill for the 39 weeks
ended November 2, 2002, was $7,000 and was due to a foreign currency translation
of goodwill at Cole Vision. The net carrying amount of tradenames at November 2,
2002 was attributable to the Cole Vision segment. Additional contingent payments
related to the 1999 acquisition of Met Life's managed vision care benefits
business increased the net carrying amount of other intangibles by $978,000, net
of related amortization of $328,000.
(3) LONG-TERM DEBT
On May 22, 2002, The Company issued $150.0 million of 8-7/8% Senior
Subordinated Notes that mature on May 15, 2012. Interest on the notes is payable
semi-annually on each May 15 and November 15, commencing November 15, 2002.
Net proceeds from the 8-7/8% note offering, together with cash on hand,
were used to retire $150.0 million of 9-7/8% Senior Subordinated Notes due 2006
and pay premiums and other costs associated with retiring those notes. The
Company's results for fiscal 2002 included an extraordinary loss on early
extinguishment of debt of approximately $7.2 million, net of an income tax
benefit of approximately $3.9 million, representing the payment of premiums and
other costs of retiring the notes and the write-offs of unamortized discount and
deferred financing fees.
On August 22, 1997, the Company issued $125.0 million of 8-5/8% Senior
Subordinated Notes that mature in 2007 with no earlier scheduled redemption or
sinking fund payments. Interest on the 8-5/8% notes is payable semi-annually on
February 15 and August 15.
The 8-5/8% notes and the 8-7/8% notes are general unsecured obligations
of the Company, subordinated in right of payment to senior indebtedness of the
Company and senior in right of payment to any current or future subordinated
indebtedness of the Company.
The indentures pursuant to which the 8-5/8% notes and the 8-7/8% notes
were issued restrict dividend payments to the Company. The indentures also
contain certain optional and mandatory redemption features and other financial
covenants.
The Company has no significant principal payment obligations under its
outstanding indebtedness until 2007, when the $125.0 million 8-5/8% Senior
Subordinated Notes are due.
During the third quarter of fiscal 2002, the Company entered into
interest rate swap agreements to take advantage of favorable market interest
rates. These agreements require the Company to pay an average floating interest
rate based on six-month LIBOR plus 4.5375% to a counter party while receiving a
fixed interest rate on a portion of the Company's $125.0 million 8-5/8% Senior
Subordinated Notes due 2007. The counter party is a major commercial bank. The
agreements mature August 15, 2007 and qualify as fair value hedges. The
aggregate notional amount of the interest rate swap agreements is $50.0 million.
At November 2, 2002, the floating rate of swaps was approximately 6.1% and the
fair value of the swap agreements was an unrealized gain of approximately $0.5
million. There was no impact to earnings in the first nine months due to hedge
ineffectiveness.
(4) CREDIT FACILITY
The operating subsidiaries of the Company have a working capital
commitment of $75.0 million that extends until May 31, 2006. Borrowings under
the credit facility presently bear interest based on leverage ratios of the
Company at a rate equal to either (a) the Eurodollar Rate plus 2.25% or (b)
1.25% plus the highest of (i) the CIBC prime rate, (ii) the three-week moving
average of the secondary market rates for three-month certificates of deposit
plus 1.0% or (iii) the federal funds rate plus 0.5%. The Company pays a
commitment fee of between 0.50% and 0.75% per annum on the total unused portion
of the facility based on the percentage of revolving credit commitments used.
Cole National Corporation and the Company guarantees this credit facility. The
credit facility is secured by the assets of the operating subsidiaries of the
Cole National Group, Inc.
The credit facility requires the principal operating subsidiaries of
Cole National Group to comply with various operating covenants that restrict
corporate activities, including covenants restricting the ability of the
subsidiaries to incur additional indebtedness, pay dividends, prepay
subordinated indebtedness, dispose of certain investments or make acquisitions.
7
The credit facility also requires the subsidiaries of Cole National Group to
comply with certain financial covenants, including covenants regarding interest
coverage and maximum leverage. On November 25, 2002 the Company received a
waiver, which expired on December 31, 2002 associated with the restatement of
the financial statements. On December 19, 2002 the credit agreement was amended
to accommodate the anticipated changes due to the restatement. The Company
received a waiver dated May 9, 2003 of the maximum leverage coverage test for
the fiscal year end 2002 and the first quarter of fiscal 2003. During the waiver
period the maximum leverage test was adjusted to accommodate the effect of the
restatement on the Company's financial statements. This waiver will expire on
the earlier of May 17, 2003 if the Lenders do not receive the Form 10-K and
10-Q's for the first through third fiscal quarters of 2002; on May 23, 2003 if
certain additional financial information is not received by the Lenders; or June
30, 2003. The Company is in compliance with the covenants in the credit
agreement and expects to meet the waiver conditions. The Company expects to
complete a permanent amendment to the credit agreement on or before June 30,
2003. However, there is no assurance that the Company will be successful in its
effort to complete such an amendment. The Company believes that even if it is
unsuccessful in its effort to complete such an amendment, it will have
sufficient liquidity from internal and other external sources.
The credit facility restricts dividend payments to the Company from its
subsidiaries to amounts needed to pay interest on the 8-7/8% notes and the
8-5/8% notes, and certain amounts related to taxes, along with up to 0.25% of
the Company's consolidated net revenue annually for other direct expenses of
Cole National Corporation or the Company. The credit facility restricts dividend
payments to the Cole National Group in an aggregate amount not to exceed $50.0
million to allow for the repurchase of Senior Subordinated Notes.
No borrowings under the credit facility were outstanding as of November
2, 2002 and November 3, 2001. There were no borrowings during the third quarter
of fiscal 2002 and 2001.
(5) SEGMENT INFORMATION
Information on the Company's reportable segments is as follows (In
thousands):
Thirteen Week Periods Thirty-Nine Week Periods
--------------------------- ---------------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Net revenue:
Cole Vision $ 221,778 $ 210,293 $ 672,827 $ 630,553
Things Remembered 53,723 53,056 180,505 179,904
--------- --------- --------- ---------
Consolidated net revenue $ 275,501 $ 263,349 $ 853,332 $ 810,457
========= ========= ========= =========
Operating income (loss):
Cole Vision $ 6,054 $ 2,319 $ 22,251 $ 15,316
Things Remembered (2,643) (811) 5,313 8,879
--------- --------- --------- ---------
Total segment operating income 3,411 1,508 27,564 24,195
Unallocated amounts:
Corporate expenses 3,560 2,440 8,560 7,267
--------- --------- --------- ---------
Consolidated operating income (loss) (149) (932) 19,004 16,928
Interest and other (income) expense, net 6,426 6,637 19,274 18,399
--------- --------- --------- ---------
Loss before income taxes $ (6,575) $ (7,569) $ (270) $ (1,471)
========= ========= ========= =========
(6) COMMITMENTS AND CONTINGENCIES
The Company leases a substantial portion of its computers, equipment
and facilities including laboratories, office and warehouse space, and retail
store locations. These leases generally have initial terms of up to 10 years and
often contain renewal options. Operating and capital lease obligations are based
upon contractual minimum rates and, in most leases covering retail store
locations, additional rents are payable based on store sales. In addition, Cole
Vision operates departments in various host stores paying occupancy costs solely
as a percentage of sales under agreements containing short-term cancellation
clauses. Generally, the Company is required to pay taxes and normal expenses of
operating the premises for laboratory, office, warehouse and retail store
leases; the host stores pay these expenses for departments operated on a
percentage-of-sales basis.
8
The Company guarantees future minimum lease payments for certain store
locations leased directly by franchisees. These guarantees totaled approximately
$13.7 million as of February 2, 2002 and November 2, 2002. Performance under a
guarantee by the Company is triggered by default of a franchisee in their lease
commitment. Generally, these guarantees also extend to payments of taxes and
other normal expenses payable under these leases, the amounts of which are not
readily quantifiable.
(7) LEGAL PROCEEDINGS
The Company and its optical subsidiaries have been sued by the State of
California, which alleges claims for various statutory violations related to the
operation of 24 Pearle Vision Centers in California. The claims include untrue
or misleading advertising, illegal dilation fees, unlawful advertising of eye
exams, maintaining an optometrist on or near the premises of a registered
dispensing optician, unlawful advertising of an optometrist, unlicensed practice
of optometry, and illegal relationships between dispensing opticians, optical
retailers and optometrists. The action seeks unspecified damages, restitution
and injunctive relief. Although the State of California obtained a preliminary
injunction to enjoin certain advertising practices and from charging dilation
fees in July 2002, the terms of the injunction have not had and are not expected
to have any material effect on the Company's operations. In addition, both the
State and the Company have appealed the preliminary injunction. The injunction
is not expected to have a material effect on the Company's operations. Although
the Company believes it is in compliance with California law and intends to
continue to defend the issues raised in the case vigorously, it may be required
to further modify its activities or might be required to pay damages and or
restitution in currently undeterminable amount if it is not successful, the cost
of which, as well as continuing defense costs, might have a material adverse
effect on the Company's operating results and cash flow in one or more periods.
Things Remembered, Inc. is in the process of settling a class action
complaint in California alleging that the putative class (alleged to include 200
members) were improperly denied overtime compensation in violation of California
law. The action sought unspecified damages, interest, restitution, as well as
declaratory and injunctive relief and attorneys' fees. On February 3, 2003,
Things Remembered and the plaintiffs reached an agreement to resolve the lawsuit
for $562,500. The settlement is subject to court approval. A liability of
$562,500 was recorded in the fourth quarter of 2002.
Cole National Corporation is defending a purported class action lawsuit
alleging claims for various violations of federal securities laws related to the
Company's publicly reported revenues and earnings. The action which proposes a
class period of March 23, 1999 through November 26, 2002 and names the Company
and certain present and former officers and directors, seeks unspecified
compensatory damages, punitive damages "where appropriate", costs, expenses and
attorneys' fees. Following the Company's announcement in November 2002 of the
restatement of the Company's financial statements (see Note 8 of the Notes to
Consolidated Financial Statements), the Securities and Exchange Commission began
an inquiry into the Company's previous accounting. The course of this or further
litigation or investigations arising out of the restatement of the Company's
financial statements cannot be predicted. In addition, under certain
circumstances the Company would be obliged to indemnify the individual current
and former directors and officers of the Company who are named as defendants in
litigation or who are or become involved in an investigation. The Company
believes it has insurance that should be available with respect to litigation
and any indemnification obligations. However, if the Company is unsuccessful in
defending against any such litigation, and if its insurance coverage is not
available or is insufficient to cover its expenses, indemnity obligations and
liability, if any, the litigation and/or investigation may have a material
adverse effect on the Company's financial condition, cash flow and results of
operations.
The Company has been named as a defendant along with numerous other
retailers, in patent infringement litigation challenging the defendants' use of
bar code technology. The Company believes it has available defenses and does not
expect any liability. However, if the Company were to be found liable for an
infringement, it might have a material adverse effect on our operating results
and cash flow in the period incurred.
In the ordinary course of business, the Company is involved in various
other legal proceedings. The Company is of the opinion that the ultimate
resolution of these matters will not have a material adverse effect on the
results of operations, liquidity or financial position of the Company.
(8) RESTATEMENT
Subsequent to the issuance of the Company's consolidated financial
statements for the second quarter of fiscal 2002, the Company determined it
needed to restate its previously issued financial statements for numerous items,
each of which was an "error" within the meaning of Accounting Principles Board
Opinion No. 20, "Accounting Changes". In addition to the restatement of its
annual financial statements, the Company has also restated its previously issued
quarterly financial statements for fiscal years 2002 and 2001.
Recognition of Revenues Earned on the Sale of Extended Warranty Contracts.
Customers purchasing eyeglasses from the Company's retail stores are offered the
option of buying a warranty for up to two years, paying in full for the warranty
at the time of sale. The Company historically recognized the revenue at the time
of the sale. The Company has made restatement adjustments to record the warranty
payment received at the time of the sale as deferred revenue and recognizes the
revenue on a straight-line basis over the warranty period.
9
Other Revenue Recognition Adjustments. Previously, the Company recognized
certain sales transactions as revenue when the customer placed the order and a
deposit was taken. Restatement adjustments were made to defer such revenue until
customer receipt or when the related goods were shipped direct to the customer
and all significant obligations of the Company were satisfied. In addition,
revenue adjustments have been made to establish adequate allowances for returns
and remakes. Historically, the Company recorded returns and remakes based on
actual product returned during the period.
Valuation of Long-lived Assets. Historically, the Company did not consider
certain mature stores with negative cash flows in its asset impairment tests. In
addition, in testing for SFAS 121 "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of" (SFAS 121), the Company did
not allocate goodwill to the respective stores. As part of the restatement, the
Company applied a methodology which includes all mature stores in its asset
impairment tests and includes an allocation of goodwill for years prior to
fiscal 2002. The restated financial statements also reflect the recognition of
losses on the disposal of fixed assets in the appropriate periods. Additional
adjustments were made to record depreciation expense for certain depreciable
fixed assets which were not previously being depreciated. Also included is an
adjustment to record capital lease assets and the corresponding lease obligation
for leases that had previously been accounted for as operating leases.
Inventories and Cost of Goods Sold. The Company's restated financial statements
reflect adjustments relating to inventories and cost of goods sold primarily to
(i) recognize obsolescence reserves in appropriate periods and amounts, correct
calculation errors and recognize certain inventory costs in appropriate periods
and (ii) reflect certain vendor allowances previously recorded in operations but
not yet earned as a reduction in the inventory balances.
Accruals for Operating Expenses. Historically, the Company did not always record
changes in estimates in the period of change, and established accruals for
certain expenses that had not yet been incurred. The restated financial
statements reflect adjustments to recognize certain operating expenses in the
period in which they were incurred and to record the corresponding liability for
those items not paid at the end of the period. Such operating expenses primarily
consist of advertising, self-insurance, IBNR claims, retirement and post
employment benefits, vacation, allowance for uncollectible accounts and
miscellaneous operating expenses.
1998 Settlement from Former Owner of Pearle. The Company's 1998 financial
statements included the recognition of $6.0 million of income from a $13.0
million cash settlement with the former owner of Pearle. The terms of the
related agreement included the settlement of certain claims and indemnifications
associated with the purchase agreement. In addition, as part of the settlement,
the Company agreed to assume certain contingent liabilities from the former
owner. The restated financial statements reflect the treatment of this $6.0
million from the settlement as an adjustment to the purchase price of Pearle,
thereby reducing the goodwill that was established in connection with the Pearle
acquisition and associated amortization expense.
Deferred Income Taxes and Income Tax Liabilities. The Company reviewed all of
its temporary differences and loss and tax credit carryforwards, and made
adjustments to its deferred tax assets and liabilities. Adjustments were made to
provide for state and local income tax deferred tax assets and liabilities,
which were previously not recorded. The Company evaluated the adequacy of the
tax liabilities established for the current and open tax years and adjusted the
amounts maintained in the tax liability accounts. Also included is the tax
effect of the restatement items.
Summary. This Form 10-Q for the quarterly period ended November 2, 2002 is being
filed at the completion of the restatement process, and at the same time as the
filing of the Company's Form 10-K for the fiscal year ended February 1, 2003.
The comparative financial information for the prior year set forth in the
financial statements of this Form 10-Q have been restated.
10
CONSOLIDATED BALANCE SHEET AS OF FEBRUARY 2, 2002
As
Previously
Reported Adjustments As Restated
---------- ----------- -----------
(Dollars in thousands)
ASSETS
Current assets:
Cash $ 63,656 $ (238) $ 63,418
Accounts receivable, less allowances 39,544 1,755 41,299
Current portion of notes receivable 2,825 (102) 2,723
Inventories 111,098 8,105 119,203
Refundable income taxes 502 (502) --
Prepaid expenses and other 22,613 6,400 29,013
Deferred income tax benefits 430 26,731 27,161
--------- --------- ---------
Total current assets 240,668 42,149 282,817
Property and equipment, at cost 291,148 7,770 298,918
Less - accumulated depreciation and amortization (169,851) (10,685) (180,536)
--------- --------- ---------
Total property and equipment, net 121,297 (2,915) 118,382
Notes receivable, excluding current portion,
less allowances 3,899 810 4,709
Deferred income taxes and other assets 49,371 16,475 65,846
Other intangibles, net -- 3,004 3,004
Tradenames, net 42,992 -- 42,992
Goodwill, net 103,552 (18,009) 85,543
--------- --------- ---------
$ 561,779 $ 41,514 $ 603,293
========= ========= =========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Current portion of long-term debt $ 54 $ 175 $ 229
Accounts payable 57,242 7,621 64,863
Payable to affiliates, net 73,548 11,929 85,477
Accrued interest 6,130 210 6,340
Accrued liabilities and deferred revenues 78,725 13,599 92,324
Accrued income taxes 546 (173) 373
Deferred revenue -- 35,401 35,401
--------- --------- ---------
Total current liabilities 216,245 68,762 285,007
Long term debt, net of discount and current portion 274,318 256 274,574
Deferred revenue, long-term -- 11,049 11,049
Other long term liabilities 12,040 5,879 17,919
Stockholder's equity 59,176 (44,432) 14,744
--------- --------- ---------
Total liabilities and stockholder's equity $ 561,779 $ 41,514 $ 603,293
========= ========= =========
11
FOR THE QUARTER ENDED NOVEMBER 3, 2001
As Previously
Reported Adjustments As Restated
------------- ------------ -------------
(In thousands)
Net revenue $ 261,488 $ 1,861 $ 263,349
Cost and expenses:
Cost of goods sold 86,906 488 87,394
Operating expenses 172,111 3,524 175,635
Goodwill and tradename amortization 1,435 (183) 1,252
--------- --------- ---------
Total costs and expenses 260,452 3,829 264,281
--------- --------- ---------
Operating income (loss) 1,036 (1,968) (932)
Interest and other (income) expense:
Interest expense 6,907 262 7,169
Interest and other (income) (189) (343) (532)
--------- --------- ---------
Total interest and other (income) expense, net 6,718 (81) 6,637
--------- --------- ---------
Income (loss) before income taxes (5,682) (1,887) (7,569)
Income tax provision (benefit) (3,978) (4,387) (8,365)
--------- --------- ---------
Net income (loss) $ (1,704) $ 2,500 $ 796
========= ========= =========
12
FOR THE THIRTY-NINE WEEKS ENDED NOVEMBER 3, 2001
As Previously
Reported Adjustments As Restated
------------- ------------- -------------
(In thousands)
Net revenue $ 805,127 $ 5,330 $ 810,457
Cost and expenses:
Cost of goods sold 264,706 (2,106) 262,600
Operating expenses 517,434 9,737 527,171
Goodwill and tradename amortization 4,333 (575) 3,758
--------- --------- ---------
Total costs and expenses 786,473 7,056 793,529
--------- --------- ---------
Operating income (loss) 18,654 (1,726) 16,928
Interest and other (income) expense:
Interest expense 20,671 445 21,116
Interest and other (income) (1,440) (1,277) (2,717)
--------- --------- ---------
Total interest and other (income) expense, net 19,231 (832) 18,399
--------- --------- ---------
Income (loss) before income taxes (577) (894) (1,471)
Income tax provision (404) (1,222) (1,626)
--------- --------- ---------
Net income (loss) $ (173) $ 328 $ 155
========= ========= =========
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Certain information required by this item has been omitted pursuant to
General Instruction H of Form 10-Q.
As discussed in Note 8 to the Consolidated Financial Statements, the
Company's financial statements have been restated. See Note 8 to the Notes to
Consolidated Financial Statements, for a summary of the significant effects of
the restatement. The following discussion of the Company's financial condition
and results of operations gives effects to the restatement and should be read in
conjunction with the Consolidated Financial Statements and related notes.
OVERVIEW
Cole National, primarily through the subsidiaries owned by its direct
subsidiary, Cole National Group, Inc., is a leading provider of optical products
and services and personalized gifts. The Company sells its products and services
through 2,509 company-owned retail locations and 447 franchised locations in 50
states, Canada and the Caribbean.
Fiscal years end on the Saturday closest to January 31 and are
identified according to the calendar year in which they begin. For example, the
fiscal year ended February 2, 2002 is referred to as "fiscal 2001." The current
fiscal year, which ends February 1, 2003, is referred to as "fiscal 2002."
Fiscal 2002 and fiscal 2001 each consisted of 52 weeks.
The Company has two reportable segments, Cole Vision and Things
Remembered. Most of Cole Vision's revenue represents sales of prescription
eyewear, accessories and services through its Cole Licensed Brands and Pearle
Vision retail locations. Cole Vision revenue also includes sales of merchandise
to franchisees, royalties based on franchise sales, initial franchise fees for
Pearle Vision and capitation revenue, administrative service fee revenue and
discount program service fees from its Cole Managed Vision business.
Things Remembered's revenue represents sales of engraveable gift
merchandise, personalization and other services primarily through retail in-line
stores and kiosks. Things Remembered revenue also includes direct sales through
its e-commerce site, http://www.ThingsRemembered.com, sales through Things
Remembered catalogs and through affiliate programs direct to businesses.
14
RESULTS OF OPERATIONS
The following schedule sets forth certain operating information for the
third quarter and first nine months fiscal 2002 and fiscal 2001. This schedule
and subsequent discussions should be read in conjunction with the consolidated
financial statements included in this Form 10-Q.
Third Quarter First Nine Months
------------------------ ------------------------
2002 2001 Change 2002 2001 Change
---------- ---------- ---------- ----------- ---------- ---------
(Dollars in millions) (Dollars in millions)
Net revenue:
Cole Vision $221.8 $210.4 5.4 % $672.8 $630.6 6.7 %
Things Remembered 53.7 53.0 1.3 180.5 179.9 0.3
---------- ---------- ----------- ----------
Total net revenue $275.5 $263.4 4.6 % $853.3 $810.5 5.3 %
Gross margin:
Cole Vision $143.8 $136.8 5.1 % $442.4 $417.7 5.9 %
Things Remembered 39.7 39.2 1.3 132.2 130.2 1.5
---------- ---------- ----------- ----------
Total gross margin $183.5 $176.0 4.3 % $574.6 $547.9 4.9 %
Operating expenses:
Cole Vision $137.7 $133.4 3.2 % $420.1 $399.3 5.2 %
Things Remembered 42.4 39.8 6.5 126.9 120.6 5.2
Unallocated corporate expense 3.6 2.5 44.0 8.6 7.3 17.8
---------- ---------- ----------- ----------
Total operating expense $183.7 $175.7 4.6 % $555.6 $527.2 5.4 %
Goodwill and tradename amortization
Cole Vision $ - $ 1.1 (100.0)% $ - $ 3.1 (100.0)%
Things Remembered - 0.2 (100.0) - 0.7 (100.0)
---------- ---------- ----------- ----------
Total goodwill and tradename amortization $ - $ 1.3 (100.0)% $ - $ 3.8 (100.0)%
Operating income (loss):
Cole Vision $ 6.1 $ 2.3 165.2 % $ 22.3 $ 15.3 45.8 %
Things Remembered (2.7) (0.8) 237.5 5.3 8.9 (40.4)
Unallocated corporate expenses (3.6) (2.5) 44.0 (8.6) (7.3) 17.8
---------- ---------- ----------- ----------
Total operating income (loss) $ (0.2) $ (1.0) (80.0)% $ 19.0 $ 16.9 12.4 %
========== ========== =========== ==========
Percentage of net revenue:
Gross margin 66.6 % 66.8 % (0.2) 67.3 % 67.6 % (0.3)
Operating expenses 66.7 66.7 0.0 65.1 65.0 0.1
Goodwill and tradename amortization - 0.5 (0.5) - 0.5 (0.5)
---------- ---------- ----------- ----------
Operating income (loss) (0.1)% (0.4)% 0.3 2.2 % 2.1 % 0.1
========== ========== =========== ==========
Number of retail locations at the end
of the period
Cole Licensed Brands 1,313 1,279
Pearle company-owned 415 430
Pearle franchised 447 423
---------- ----------
Total Cole Vision 2,175 2,132
Things Remembered 781 790
---------- ----------
Total Cole National 2,956 2,922
========== ==========
15
As used in Item 2 of this Form 10-Q, same-store sales growth is a
non-GAAP financial measure, which includes deferred warranty sales on a cash
basis and does not reflect provisions for returns and remakes and certain other
items. The Company's current systems do not gather data on these items on an
individual store basis. Adjustments to the cash basis sales information
accumulated at the store level are made for these items on an aggregate basis.
As a retailer, the Company believes that a measure of same-store sales
performance is important for understanding its operations. The Company
calculates same-store sales for stores opened for at least twelve months. A
reconciliation of same-store sales to revenue is presented below in the section
"Reconciliation of Same-Store Sales Growth." Same-store sales growth follows:
2002
-------------------------------------------------
Third Quarter First Nine Months
------------------- ------------------
Cole Licensed Brands (U.S.) 6.5% 5.2%
Pearle company-owned (U.S.) 2.0% 4.8%
Total Cole Vision 4.7% 4.7%
Things Remembered (1.4)% (1.9)%
Total Cole National 3.4% 3.1%
Pearle franchise stores (U.S.) (1.8)% 1.6%
Same-store sales for Pearle U.S. franchise stores is a non-GAAP
financial measure that is provided for comparative purposes only. The Company
believes that its franchisees' method of reporting sales is consistent on a
year-to-year basis.
THIRD QUARTER FISCAL 2002 COMPARED TO THIRD QUARTER FISCAL 2001
CONSOLIDATED OPERATIONS
Total revenues were $275.5 million in the third quarter of fiscal 2002,
compared with $263.4 million in the same period of fiscal 2001. Total revenues
increased 4.6% in the third quarter, primarily attributable to a 3.4% increase
in same-store sales, an increase in the number of Target Optical stores open,
and an increase in revenues from managed vision care programs.
Gross margin was $183.5 million in the third quarter of fiscal 2002,
compared with $176.0 million in the same period of fiscal 2001, an increase of
4.3%. The gross margin dollar increase was primarily attributable to
improvements in net revenue at Cole Vision. The gross margin rate for the third
quarter was 66.6%, compared to 66.8% for the third quarter 2001. The decline was
attributable to lower gross margin percents at Cole Vision, partially offset by
a small gross margin rate improvement at Things Remembered.
Operating expenses were $183.7 million in the third quarter of fiscal
2002, compared with $175.7 million in the same period of fiscal 2001, an
increase of 4.6%. The increase in operating expenses was primarily due to costs
incurred to support the increase in net revenue and the number of Target Optical
stores opened in the past twelve months. As a percentage of net revenue,
operating expenses were the same as the third quarter 2001. Executive severance
costs of $0.7 million and expenses totaling $0.3 million associated with the
closing of the corporate office and relocating it to the Company's facility in
Twinsburg, Ohio, were the primary reasons for the increase in corporate expense.
In addition, the Company reversed expense accruals related to benefits and legal
costs totaling $0.4 million in fiscal 2001 due to favorable experience. This
reversal of expense was not repeated in the third quarter of fiscal 2002.
Operating expenses at Things Remembered increased $2.6 million on a sales
increase of $0.7 million. Higher costs of rent and occupancy, resulting from
increases in insurance, taxes and other common area charges were the primary
reasons for the increase. These increases were offset by lower operating expense
percent at Cole Vision, primarily at Target Optical. Results at Target Optical
improved as the focus changed from an aggressive growth rate in store openings
to measured growth and improved operations. Operating expenses as a percent of
sales also improved at Cole Managed Vision, due to reductions in the cost per
claim processed.
The Company adopted SFAS 142, "Goodwill and Other Intangible Assets",
(SFAS 142), in the first quarter of fiscal 2002. SFAS 142 requires that goodwill
and certain intangibles deemed to have indefinite lives no longer be amortized,
but instead, will be subject to annual reviews for impairment. With the adoption
of this statement, the Company ceased amortization of goodwill and tradenames as
of February 3, 2002. The Company recorded a $1.3 million goodwill and tradename
amortization charge in the third quarter of fiscal 2001.
16
Operating loss was $0.2 million in the third quarter of fiscal 2002,
compared to an operating loss of $1.0 million in the same period of fiscal 2001.
Improvements at Cole Vision and the cessation of goodwill and tradename
amortization were partially offset by a decline in operating income at Things
Remembered and the increase in corporate expenses mentioned above.
Interest and other (income) expense, net, decreased $0.2 million
compared to the same period in fiscal 2001 primarily because of lower interest
expense from the May 2002 refinancing. Cole National Group issued $150.0 million
of 8-7/8% Senior Subordinated Notes due 2012 and used the proceeds to retire
$150.0 million 9-7/8% Senior Subordinated Notes due 2006. The issuance and
retirement will reduce cash interest expense by $1.5 million on an annual basis.
The difference between the statutory tax rate and the higher effective
tax rates in each fiscal year is primarily due to the provision for state income
taxes, the provision for valuation allowances related to deferred tax assets for
charitable contributions carryforwards, foreign income, other nondeductible
items, and in 2001 goodwill amortization.
COLE VISION SEGMENT
Cole Vision revenues were $221.8 million in the third quarter of fiscal
2002, compared with $210.4 million in the comparable period of fiscal 2001, an
increase of 5.4%. Same-store sales for the third quarter of fiscal 2002
increased 6.5% at Cole Licensed Brands and 2.0% at Pearle Vision company-owned
stores. Same-store sales reflected an increase in the average spectacle selling
price and an increase in transactions.
Gross margin as a percentage of net revenue decreased by 0.2 percentage
points at Cole Vision and was impacted by the continuation of a program to price
contact lenses more competitively in order to gain market share, and increase in
product sold to Pearle franchisees. Partially offsetting these factors were the
increase in average spectacle selling price and growth in managed vision care
claims and fee revenue. Product sales to franchisees carry a lower margin but
offer benefits for the Company, including helping franchise same-store sales and
producing a more uniform merchandise assortment and consistent brand look across
all stores.
Operating expenses were 3.2% higher at Cole Vision in the third quarter
of fiscal 2002. Revenue growth of $11.4 million was the primary reason for the
increase. Operating expenses as a percent of sales decreased 1.3% in the third
quarter, resulting primarily from operating improvements and the change from
fixed to percentage rent at Target Optical.
Operating income at Cole Vision improved to $6.1 million in the third
quarter of fiscal 2002, compared with $2.3 million in the comparable period of
fiscal 2001. Increases in revenue and the operating efficiencies at Target
Optical were the primary reasons for the improvement. In addition, the cessation
of goodwill and tradename amortization in fiscal 2002 resulted in $1.1 million
of improved operating income.
THINGS REMEMBERED SEGMENT
Things Remembered sales were $53.7 million in the third quarter of
fiscal 2002, compared with $53.0 million in the comparable period of fiscal
2001, a 1.3% increase. Same-store sales declined 1.4% as fewer transactions
offset the increase in average selling price resulting from sales of new
merchandise at higher average unit prices, higher revenue from merchandise
personalization, and less merchandise sold at clearance prices.
Gross margin as a percent of net revenue increased 0.1% in the third
quarter of fiscal 2002 compared to the comparable period of fiscal 2001.
Operating expenses at Things Remembered increased $2.6 million on a
sales increase of $0.7 million. Higher costs of rent and occupancy, resulting
from increases in insurance, taxes and other common area charges were the
primary reason. These charges are generally variable and can increase as mall
ownership and or tenant occupancy rates change. Costs of marketing were also
higher due to efforts to increase sales in a difficult retail environment. Costs
of store payroll also grew at a slightly higher rate then the increase in sales,
due to higher wage rate and benefit costs.
17
Operating loss for the third quarter of 2002 was $2.7 million compared
to a loss of $0.8 million in the comparable period of 2001. Higher costs of
rent, occupancy, store payroll and marketing rising faster than the increase in
revenue, were the primary reasons for the increase in operating loss.
FIRST NINE MONTHS FISCAL 2002 COMPARED TO FIRST NINE MONTHS FISCAL 2001
CONSOLIDATED OPERATIONS
Total revenue was $853.3 million for the first nine months of fiscal
2002, compared to $810.5 million for the comparable period of fiscal 2001. Total
revenue increased 5.3% during this period, primarily attributable to a 3.1%
increase in same-store sales, an increase in the number of Target Optical stores
open, and an increase in Cole Managed Vision revenues.
Gross margin increased $26.7 million, or 4.9% in the first nine months
of fiscal year 2002 compared to the same period a year ago. The gross margin
dollar increase was primarily attributable to improvements in net revenue at
Cole Vision. The gross margin rate decreased to 67.3% in fiscal 2002 from 67.6%
in fiscal 2001 due to a 0.5 percentage point decrease at Cole Vision offset by a
0.9 percentage point margin improvement at Things Remembered. The decline in
gross margin rate at Cole Vision was attributable to the same factors affecting
gross margin in the third quarter. The improvement in gross margin rate at
Things Remembered was due to a change in sales mix to higher-end products.
Operating expenses increased $28.4 million, or 5.4% for the first nine
months of fiscal 2002 compared to the same period in fiscal 2001. The increase
in operating expenses was primarily due to costs incurred to support the
increase in net revenue and the number of Target Optical stores opened in the
past twelve months. For the first nine months, operating expenses as a
percentage of net revenue were slightly higher than the comparable period last
year. Improvements at Cole Vision were offset by higher operating costs at
Things Remembered. For the first nine months of fiscal 2002, operating costs at
Things Remembered increased $6.3 million on a total revenue increase of $0.6
million. Higher costs of rent and occupancy resulting from increases in
insurance, taxes and other common area charges, as well as increased costs of
store payroll and marketing were the primary reasons for the increase. Corporate
expenses were also higher in the first nine months of fiscal 2002, compared to
the comparable period of 2001. Executive severance costs of $0.7 million and
expenses totaling $0.3 million associated with the closing of the corporate
office and relocating it to the Company's facility in Twinsburg, Ohio were the
primary reasons for the increase in corporate expense.
The Company adopted SFAS 142 in the first quarter of fiscal 2002. SFAS
142 requires that goodwill and certain intangibles deemed to have indefinite
lives no longer be amortized, but instead, will be subject to annual reviews for
impairment. With the adoption of this statement, the Company ceased amortization
of goodwill and tradenames as of February 3, 2002. The Company recorded a $3.8
million goodwill and tradename amortization charge for the first nine months of
fiscal 2001.
Operating income for the first nine months of fiscal 2002 was $19.0
million, compared with $16.9 million for the comparable period of fiscal 2001, a
12.4% improvement. The $2.1 million improvement in operating income for the
first nine months reflected the elimination of goodwill and tradename
amortization from adopting SFAS 142 and improved operating earnings at Cole
Vision. These were partially offset by lower operating earnings at Things
Remembered and the increase in corporate expenses discussed above.
For the first nine months of fiscal 2002, interest and other (income)
expense, net was $0.9 million higher than the comparable period of fiscal 2001.
The Company recorded lower interest income from franchise receivables and from
temporary investments of excess cash. In addition, the Company recorded a $0.7
million gain from the sale of a Dallas, Texas office facility in the first
quarter of fiscal 2001. Partially offsetting this was the reduction of interest
expense in fiscal 2002 from the refinancing of the Company's $150.0 million
Senior Subordinated Notes. See Note 3 for further information regarding this
transaction.
The difference between the statutory tax rate and the higher effective
tax rates in each fiscal year is primarily due to the provision for state income
taxes, the provision for valuation allowances related to deferred tax assets for
charitable contributions carryforwards, foreign income, other nondeductible
items, and in 2001 goodwill amortization.
18
The results for the first nine months of fiscal 2002 include an
extraordinary loss on early extinguishment of debt of $7.2 million, net of an
income tax benefit of $3.9 million. The extraordinary charge represents payment
of premiums and other costs of retiring Cole National Group's 9-7/8% Senior
Subordinated Notes due 2006 and the write-offs of unamortized discount and
deferred financing fees. See the section below entitled "Liquidity and Capital
Resources" and Note 3 of the Notes to Consolidated Financial Statements for more
information regarding the early extinguishment of debt.
COLE VISION SEGMENT
Cole Vision revenues were $672.8 million for the first nine months of
fiscal 2002, compared with $630.6 million for the comparable period of fiscal
2001. Same-store sales for the first nine months of fiscal 2002 increased in all
retail vision brands, despite the difficult retail environment. Cole Licensed
Brands and Pearle Vision company-owned locations increased same-store sales by
5.2% and 4.8%, respectively. Same-store sales reflected an increase in the
average spectacle selling price and strong transaction increases at Target
Optical. Same-store sales increases also reflected strong first quarter
transaction increases at Pearle Vision.
Gross margin rate decreased 0.5% for the first nine months of fiscal
2002, compared to the comparable period in fiscal 2001. The decrease in the nine
month gross margin rate at Cole Vision was attributable to the same factors
affecting third quarter gross margin discussed above.
Operating expenses were 5.2% higher at Cole Vision in the first nine
months of fiscal 2002 compared to the comparable period in fiscal 2001. Revenue
growth of $42.2 million was the primary reason for the increase. Operating
expenses as a percent of sales declined 0.9% in the first nine months, resulting
primarily from operating improvements at Cole Managed Vision and Pearle Vision.
Operating expenses at Cole Managed Vision declined as a percent of sales in the
first nine months of fiscal 2002 compared to the comparable period the prior
year due to the reduction of processing fees paid to Met Life as claims
processing was converted to the Company's internal systems at a lower cost per
claim. Improvements at Pearle Vision were due to lower costs of advertising, due
to lower national media spending.
Operating income at Cole Vision improved to $22.3 million for the first
nine months of fiscal 2002, compared to $15.3 million for the comparable period
of fiscal 2001. Improved operating earnings at Pearle Vision resulting from
higher revenues and lower advertising expenses, improvements in the processing
cost per claim at Cole Managed Vision, and the cessation of goodwill and
tradename amortization were the primary reasons for the increase. Goodwill and
tradename amortization at Cole Vision totaled $3.1 million during the first nine
months of fiscal 2001.
THINGS REMEMBERED SEGMENT
Things Remembered sales were $180.5 million for the first nine months
of fiscal 2002, compared with $179.9 million for the comparable period of fiscal
2001. Same-store sales declined 1.9% as fewer transactions offset the increase
in average selling price resulting from sales of new merchandise at higher
average unit prices, higher revenue from merchandise personalization, and less
merchandise sold at clearance prices.
The gross margin rate increased 0.9% at Things Remembered for the first
nine months of fiscal 2002 compared to the comparable period of fiscal 2001. The
increase in gross margin rate was primarily attributable to a change in sales
mix to higher end product.
Operating expenses were 5.2% higher at Things Remembered in the first
nine months of fiscal 2002 compared to the comparable period in fiscal 2001. The
increase in operating expenses, coupled with a 0.3% increase in sales, resulted
in higher operating expense percent of 3.3%. Higher costs of rent and occupancy,
resulting from increases in insurance, taxes, and other common area charges were
the primary reason for the increase. Costs of marketing were also higher due to
efforts to increase sales in a difficult retail environment. Costs of store
payroll also grew at a slightly higher rate then the increase in sales, due to
higher wage rate and benefit costs.
Operating income decreased to $5.3 million for the first nine months of
fiscal 2002, compared to $8.9 million in the comparable period of fiscal 2001.
Higher rent, occupancy, store payroll and marketing costs rising faster than the
revenues were the primary causes of the reduction in operating income.
19
RECONCILIATION OF SAME-STORE GROWTH
Same-store sales growth is a non-GAAP financial measure, which includes
deferred warranty sales on a cash basis and does not reflect provisions for
returns and remakes and certain other items. The Company's current systems do
not gather data on these items on an individual store basis. Adjustments to the
cash basis sales information accumulated at the store level are made for these
items on an aggregate basis. As a retailer, the Company believes that a measure
of same-store sales performance is important for understanding its operations.
The Company calculates same-store sales for stores opened for at least twelve
months. A reconciliation of same-store sales to revenue reported on a GAAP basis
follows:
2002
-------------------------------
Third Quarter Nine Months
------------- -----------
(Dollars in thousands)
Current year same-store sales $ 237,824 $ 736,790
Prior year same-store sales 230,108 714,585
Percent Change 3.4% 3.1%
Current year same-store sales 237,824 736,790
Adjustment for:
Sales at new and closed stores 7,212 24,140
Extended warranties (781) (2,932)
Order vs. customer receipt 1,428 1,066
Returns, remakes and refunds (1,183) (1,489)
Other (107) (113)
--------- ---------
Store sales 244,393 757,462
Nonstore revenues 38,104 117,796
Intercompany eliminations (6,996) (21,926)
--------- ---------
GAAP Basis Net Revenue $ 275,501 $ 853,332
========= =========
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of liquidity is funds provided from the
operations of its operating subsidiaries. In addition, as of November 2, 2002,
the Company and its operating subsidiaries had a working capital commitment of
$75.0 million. Availability under the credit facility totaled $62.7 million,
after reduction for commitments under outstanding letters of credit. There were
no working capital borrowings outstanding at any time during the first nine
months of fiscal 2002 or fiscal 2001. The Company and its principal operating
subsidiaries are in compliance with all credit facility covenants as of November
2, 2002.
The credit facility, which is guaranteed by Cole National Corporation
and the Company, requires the Company and its principal operating subsidiaries
to comply with various operating covenants that restrict corporate activities,
including covenants restricting the ability of the subsidiaries to incur
additional indebtedness, pay dividends, prepay subordinated indebtedness,
dispose of certain investments or make acquisitions. The credit facility also
requires the Company to comply with certain financial covenants, including
covenants regarding minimum interest coverage and maximum leverage.
On May 22, 2002, the Company issued $150.0 million of 8-7/8% Senior
Subordinated Notes due 2012. The notes are unsecured and mature on May 15, 2012.
Net proceeds from the notes offering, together with cash on hand, were used to
retire $150.0 million of 9-7/8% Senior Subordinated Notes due 2006 and pay
premium and other costs associated with retiring those notes. An extraordinary
loss on early extinguishment of debt of $7.2 million, which is net of an income
tax benefit of $3.9 million, representing the payment of premiums and other
costs of retiring the notes and write-offs of unamortized discount and deferred
financing fees, was recorded in the second quarter of fiscal 2002.
20
The indentures pursuant to which the 8-5/8% notes and the 8-7/8% notes
were issued contain certain optional and mandatory redemption features and other
financial covenants, including restrictions on the ability of the Company to
incur additional indebtedness, pay dividends or make other restricted payments
to Cole National Corporation. The indentures also permit payments to Cole
National Corporation for certain tax obligations and for administrative expenses
not to exceed 0.25% of net sales. See Note 3 of the Notes to Consolidated
Financial Statements. The Company may from time to time purchase its outstanding
notes in the open market or refinance them depending on capital market
conditions.
No significant principal payment obligations are due under the
Company's outstanding indebtedness until 2007 when the $125.0 million Senior
Subordinated debt is due. The ability of Cole National Corporation and its
subsidiaries to satisfy their obligations will be primarily dependent upon the
future financial and operating performance of the subsidiaries and upon the
Company's ability to renew or refinance borrowings or raise additional capital
through equity financing or sales of assets.
Operations for the first nine months provided $22.1 million of cash in
fiscal 2002 compared with $7.3 million in fiscal 2001. Changes in working
capital resulted in a use of funds of $5.3 million in fiscal 2002, compared to a
use of funds of $21.9 million in fiscal 2001. Changes in accounts payable and
other liabilities resulted in a source of cash of $16.4 million in fiscal 2002
compared to a use of funds of $11.4 million in fiscal 2001. The benefit of the
increase in payables and other liabilities was due to timing of purchases and
payments and increases in deferred warranties. Changes in receivable and other
assets resulted in a use of funds of $5.4 million compared to a source of funds
of $5.2 million in fiscal 2001. The increase in receivables was due to increases
in sales and corresponding receivables at Cole Vision. Results of operations,
lower depreciation and amortization and non-cash interest charges provided lower
funds from operations.
Net cash from investing activities resulted in a use of funds of $38.3
million for the first nine months of fiscal 2002 compared to a use of funds
totaling $29.2 million in the comparable period of fiscal 2001. Capital
expenditures, which accounted for most of the cash used for investing, were
$33.3 million and $27.3 million in fiscal 2002 and fiscal 2001, respectively.
The majority of capital expenditures were for store fixtures, equipment and
leasehold improvements for new stores, including the Target Optical expansion,
and remodeling of existing stores. Expenditures for systems development costs
totaled $3.7 million and $5.8 million for the first nine months of fiscal 2002
and fiscal 2001, respectively. In fiscal 2001, net proceeds of $4.7 million were
received from the sale of a Dallas office facility. The Company used $0.7
million for contingent payments in connection with the prior acquisition of
MetLife's managed vision business.
Net cash used for financing activities totaled $25.9 million for the
first nine months of fiscal 2002, compared to a source of funds totaling $6.6
million for the comparable period of fiscal 2001. In May 2002, Cole National
Group, Inc., issued $150.0 million of 8-7/8% Senior Subordinated Notes due May
2012. The net proceeds of this issuance and cash on hand were used to retire all
of Cole National Group's $150.0 million 9-7/8% Senior Subordinated Notes due
2006. Finance fees and early repayment of the 9-7/8% notes resulted in a net
cash usage of $14.2 million. See Note 3 for further information regarding this
transaction. Advances to affiliates totaled $5.1 million in fiscal 2002,
compared to $5.8 million in fiscal 2001.
The Company believes that funds provided from operations, including
cash on hand, along with funds available under the credit facility will provide
adequate sources of liquidity to allow its operating subsidiaries to continue to
expand the number of stores and to fund capital expenditures and system
development costs.
OFF BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL COMMITMENTS
The Company leases a substantial portion of its equipment and
facilities including laboratories, office and warehouse space, and retail
locations. In addition, Cole Vision operates departments in various host stores
and pays occupancy costs solely as a percentage of sales. A more complete
discussion of the Company's lease and license commitments is included in Note 6
of the Notes to Consolidated Financial Statements.
The Company guarantees future minimum lease payments for certain store
locations leased directly by Pearle franchisees. The term of these guarantees
range from one to ten years of which many are limited to periods that are less
than the full term of the leases involved. A more complete discussion of the
Company's guarantees is included in Note 6 of the Notes to Consolidated
Financial Statements.
Changes in overdraft balances resulted in a use of funds of
$6.3 million in fiscal 2002 compared to a source of funds of $12.6 million
in fiscal 2001. The decrease was due to the timing of payments.
21
The Company's primary source of liquidity, other than cash on hand, is
the working capital line of credit discussed above and in Note 4 of the Notes to
Consolidated Financial Statements. This facility has been extended until May 31,
2006 and supports $12.3 million of standby letters of credit that are renewable
annually.
RECENTLY ISSUED ACCOUNTING STANDARDS
The Company adopted SFAS 142, "Goodwill and Other Intangible Assets"
(SFAS 142) in the first quarter of fiscal 2002. This statement requires that
goodwill and certain intangible assets deemed to have indefinite useful lives no
longer be amortized, but instead be subject to at least an annual review for
impairment. With the adoption of this statement, the Company ceased amortization
of goodwill and tradenames as of February 3, 2002. Amortization of goodwill and
tradenames totaled $5.0 million in fiscal 2001.
During the second quarter of fiscal 2002, the Company completed the
transitional impairment testing of goodwill as required by SFAS 142. Based on
the findings of its outside valuation advisor, the Company has concluded that
there was no impairment of its goodwill or tradenames at the adoption date of
the new accounting standard, effective February 3, 2002. The Company has elected
to perform its annual tests for potential impairment as of the first day of the
Company's fourth quarter. Based on its annual tests performed in the fourth
quarter of fiscal 2002, the Company has concluded that there was no impairment
of its goodwill or tradenames. As part of the restatement, the Company and its
outside valuation advisor reviewed the previously completed impairment testing
and confirmed that there was no impairment of either goodwill or tradenames.
The Financial Accounting Standards Board (FASB) has issued SFAS No.
145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of SFAS
Statement No. 13, and Technical Corrections" (SFAS 145). SFAS 145 states that
the rescission of SFAS No. 4 shall be applied in fiscal years beginning after
May 15, 2002. Any gain or loss on extinguishment of debt that was classified, as
an extraordinary item in prior periods presented that does not meet the criteria
in APB Opinion 30, "Reporting the Results of Operations - Reporting the Effects
of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions", for classification as an
extraordinary item shall be reclassified as an operating expense. The Company
will adopt SFAS 145 as of the beginning of fiscal 2003. As a result, the loss on
early extinguishment of debt reported as an extraordinary item for the year
ended February 1, 2003 will be reclassified at that time. The pretax loss from
the early extinguishment of debt will be presented as a separate line within
interest and other (income) expenses and the related income tax benefit will
reduce the reported income tax provision.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS 146). This statement requires
that a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. The provisions of this statement were
effective for exit or disposal activities initiated after December 31, 2002. The
Company will adopt SFAS 146 on January 1, 2003. The adoption will have no effect
on the Company's financial position or operations.
The FASB has also issued SFAS No. 143, "Accounting for Asset Retirement
Obligations" (SFAS 143), and SFAS No. 144, "Accounting for Impairment or
Disposal of Long-Lived Assets" (SFAS 144). SFAS 143 provides guidance for legal
obligations arising from the retirement of long-lived assets. SFAS 144 addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets. SFAS 144 was adopted during fiscal 2002 and had no effect on the
Company's financial position or operations. SFAS 143 will be adopted during
fiscal 2003 and is not expected to have a material effect on the Company's
financial position or operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" (FIN 45). This interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The Company will adopt the fair value recognition
provision of this interpretation for guarantees issued or modified after
December 31, 2002. The disclosure provisions of the interpretation will be
adopted for the year ended February 1, 2003.
22
CONTINGENCIES
A complaint was filed in the Superior Court of California, county
of San Diego against Cole National Corporation, its affiliates and certain of
its officers by the Attorney General of the State of California on February 14,
2002 and amended on February 22, 2002. The case, State of California v. Cole
National Corporation, et. al., alleges claims for various statutory violations
related to the operation of 24 Pearle Vision Centers in California. The claims
include untrue or misleading advertising, illegal dilation fees, unlawful
advertising of eye exams, maintaining an optometrist on or near the premises of
a registered dispensing optician, unlawful advertising of an optometrist,
unlicensed practice of optometry, and illegal relationships between dispensing
opticians, optical retailers and optometrists. The action seeks unspecified
damages, restitution and injunctive relief. Although the State of California
obtained a preliminary injunction to enjoin certain advertising practices and
the charging of dilation fees in July 2002, the terms of the injunction have not
had and are not expected to have a material effect on the Company operations. In
addition, both the State and the Company have appealed the preliminary
injunction. Although we believe we are in compliance with California law and
intend to continue to defend the issues raised in the case vigorously, the case
is in its early stages and we cannot predict with certainty its outcome or
costs.
Cole National Corporation is defending a purported class action lawsuit
alleging claims for various violations of federal securities laws related to the
Company's publicly reported revenues and earnings. The action, which proposes a
class period of March 23, 1999 through November 26, 2002 and names the Company
and certain present and former officers and directors as defendants, seeks
unspecified compensatory damages, punitive damages "where appropriate", costs,
expenses and attorneys fees. The Company believes it has insurance that should
be available with respect to litigation and any indemnification obligations.
However, if the Company is unsuccessful in defending against any such
litigation, and if its insurance coverage is not available or is insufficient to
cover its expenses, indemnity obligations and liability, if any, the litigation
and/or investigation may have a material adverse effect on the Company's
financial condition, cash flow and results of operations.
The Company has been named as a defendant along with numerous other
retailers, in patent infringement litigation challenging the defendants' use of
bar code technology. The Company believes it has available defenses and does not
expect any liability. However, if the Company were to be found liable for an
infringement, it might have a material adverse effect on our operating results
and cash flow in the period incurred.
FORWARD LOOKING STATEMENTS
The Company's expectations and beliefs concerning the future contained
in this document are forward looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Actual results may differ
materially from those forecasted due to a variety of factors that can adversely
affect the Company's operating results, liquidity and financial condition such
as risks associated with potential adverse consequences of the restatement of
the Company's financial statements, including those resulting from litigation or
government investigations, restrictions or curtailment of the Company's credit
facility and other credit situations, costs and other effects associated with
the California litigation, the timing and achievement of improvements in the
operations of the optical business, the results of Things Remembered, which is
highly dependent on the fourth quarter holiday season, the nature and extent of
disruptions of the economy from terrorist activities or major health concerns,
and from governmental and consumer responses to such situations, the actual
utilization of Cole Managed Vision funded eyewear programs, the success of new
store openings and the rate at which new stores achieve profitability, the
Company's ability to select, stock and price merchandise attractive to
customers, success of systems development and integration, competition in the
optical industry, integration of acquired businesses, economic and weather
factors affecting consumer spending, operating factors affecting customer
satisfaction, including manufacturing quality of optical and engraved goods, the
Company's relationships with host stores and franchisees, the mix of goods sold,
pricing and other competitive factors, and the seasonality of the Company's
business.
23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's major market risk exposure is to changes in foreign
currency exchange rates in Canada and in Euros, which could impact its results
of operations and financial condition. Foreign exchange risk arises from the
Company's exposure to fluctuations in foreign currency exchange rates because
the Company's reporting currency is the United States dollar. Management seeks
to minimize the exposure to foreign currency fluctuations through natural
internal offsets to the fullest extent possible.
During the third quarter of 2002, the Company entered into an interest
rate swap agreement to take advantage of favorable market interest rates. These
agreements require the Company to pay an average floating interest rate based on
six month LIBOR plus 4.5375% to a counter party while receiving a fixed rate on
$50.0 million of the Company's $125.0 million 8-5/8% Senior Subordinated Notes
due 2007. The agreements mature August 15, 2007 and qualify as fair value
hedges. The LIBOR rate is reset in arrears. For the third quarter, the market
rate for six month LIBOR was 1.57438% which resulted in a rate of 6.1190%
applied from the inception date of the swaps through November 2, 2003.
A change in six-month LIBOR would effect the interest cost associated
with the $50.0 million notional value of the swap. A 50% change (approximately
79 basis points) in the market rates of interest for six month LIBOR as
compared to the 6.1190% rate in effect for the third quarter of 2002 would
increase the Company's annual interest cost by $0.4 million.
In addition, the Company is exposed to changes in the fair value of our
debt portfolio, primarily resulting from the effects of changes in interest
rates. The Company utilizes interest rate swaps to manage its exposure.
Management believes that its use of these financial instruments is in the
Company's best interest. The Company does not enter into financial instruments
for trading purposes.
ITEM 4. CONTROLS AND PROCEDURES
(a) Immediately following the Signature section of this Quarterly
Report are certifications of the Company's Chief Executive Officer and Chief
Financial Officer required in accordance with Section 302 of the Sarbanes-Oxley
Act of 2002 (the "Section 302 Certification"). This portion of our Quarterly
Report on Form 10-Q is our disclosure of the results of our control evaluation
referred to in paragraphs (4), (5) and (6) of the Section 302 Certification and
should be read in conjunction with the Section 302 Certification for a more
complete understanding of the topics presented.
In November 2002, the Company determined it needed to restate its
previously issued financial statements for the timing of the recognition of
revenues earned on the sale of extended warranty contracts. The Company issued a
press release on November 26, 2002 announcing the restatement of its historical
consolidated financial statements beginning with its 1998 fiscal year. The
Company subsequently determined that it needed to make changes to previously
issued financial statements in addition to the timing of the recognition of
warranty revenues. The adjustments have a significant negative impact on the
Company's previously reported revenue, net income, and earnings per share. See
Note 8 to the Notes to Consolidated Financial Statements for further discussion
of the restatement.
In March 2003, the Audit Committee engaged outside counsel to conduct
an inquiry into the issues surrounding the restatement. The results and
conclusions of that inquiry have been considered in the preparation of the
accompanying financial statements.
Within 90 days prior to the filing date of this Form 10-Q, the Company
carried out an evaluation, under the supervision and with the participation of
its Chief Executive Officer and Chief Financial Officer, pursuant to Rule 13a-15
promulgated under the Securities Exchange Act of 1934 (the "Exchange Act"), as
amended, of the effectiveness of the design and operation of its disclosure
controls and procedures. In making this evaluation, the Company has considered
matters relating to its restatement of previously issued financial statements,
including the substantial process that was undertaken to ensure that all
material adjustments necessary to restate the previously issued financial
statements were recorded. The Company believes that certain of the restatement
adjustments occurred because certain of the Company's control processes and
procedures related to the matters underlying such adjustments were not
effective.
24
In connection with the audit of the Company's financial statements
for the 2002 fiscal year and the restated financial statements for the 2001 and
2000 fiscal years, Deloitte & Touche reported to management and the Board of
Directors on April 30, 2003 that certain deficiencies existed during the audit
period in the design or operation of the Company's internal accounting controls
which constituted material weaknesses pursuant to standards established by the
American Institute of Certified Public Accountants. Such deficiencies related to
the application or selection of accounting principles, the use of management
judgment and estimates, and the adequacy of account details and reconciliations.
In order to improve the effectiveness of its control processes and
procedures, the Company has taken a number of actions within the past year. The
Company searched for and hired a new Chief Financial Officer from outside the
Company, and filled the position of Corporate Controller. The Audit Committee
approved a charter for the Internal Audit function; the Internal Audit staff was
strengthened and its role was expanded. The Company established an internal
representation requirement, whereby the operating executive and financial
officer of each business unit and major staff area are required to certify on a
quarterly basis the accuracy of the financial statements and the adequacy of the
control processes and procedures within that business unit or staff area. With
the approval of the Board of Directors, the Company amended its Business Code of
Conduct, and required that all management employees certify in writing that they
will comply with it. The Business Code of Conduct includes procedures for the
receipt, retention and treatment of complaints received from employees
regarding, among other things, accounting and internal accounting control
matters. The Company is currently revising its Finance and Accounting Policies
and Procedures Manual.
Based in part upon these changes, the Company's Chief Executive
Officer and Chief Financial Officer concluded that as of the evaluation date,
the Company's disclosure controls and procedures were reasonably designed to
ensure that information required to be disclosed by the Company in the reports
it files or submits under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in the rules and forms of the
Securities and Exchange Commission.
(b) Other than as described above, since the evaluation date by the
Company's management of its internal controls, there have not been any
significant changes in the internal controls or in other factors that could
significantly affect the internal controls.
25
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time during the ordinary course of business, the Company may
be threatened with, or may become a party to, a variety of legal actions and
other proceedings incidental to its business.
A complaint was filed in the Superior Court of California, county of San
Diego against Cole National Corporation, its affiliates and certain of its
officers by the Attorney General of the State of California on February 14, 2002
and amended on February 22, 2002. The case, State of California v. Cole National
Corporation, et al., alleges claims for various statutory violations related to
the operation of 24 Pearle Vision Centers in California. The claims include
untrue or misleading advertising, illegal dilation fees, unlawful advertising of
eye exams, maintaining an optometrist on or near the premises of a registered
dispensing optician, unlawful advertising of an optometrist, unlicensed practice
of optometry, and illegal relationships between dispensing opticians, optical
retailers and optometrists. The action seeks unspecified damages, restitution
and injunctive relief. Although the State of California obtained a preliminary
injunction to enjoin certain advertising practices and the charging of dilation
fees in July 2002, the terms of the injunction have not had and are not expected
to have a material effect on the Company's operations. In addition, both the
State and the Company have appealed the preliminary injunction. Although we
believe we are in compliance with California law and intend to continue to
defend the issues raised in the case vigorously, the case is in its early stages
and we cannot predict with certainty its outcome or costs.
A class action complaint was filed on August 14, 2002 in the Superior
Court of San Francisco, California, against Things Remembered by a purported
class of approximately 200 employees of Things Remembered alleging that the
members of the putative class were improperly denied overtime compensation in
violation of California law. The action sought unspecified damages, interest,
restitution, as well as declaratory and injunctive relief and attorneys' fees.
On February 3, 2003, Things Remembered and the plaintiffs reached an agreement
to resolve the lawsuit for $562,500. The settlement is subject to court
approval.
A class action complaint was filed on December 6, 2002 in the United
States District Court for the Northern District of Ohio against Cole National
Corporation and certain present and former officers and directors by a purported
class of shareholders of the Company alleging claims for various violations of
federal securities laws related to Cole National Corporation's publicly reported
revenues and earnings. The action, which proposes a class period of March 23,
1999 through November 26, 2002 and names Cole National Corporation and certain
present and former officers and directors, seeks unspecified compensatory
damages, punitive damages "where appropriate", costs, expenses and attorneys
fees. Following the announcement in November 2002 of the restatement of the
Company's financial statements, the Securities and Exchange Commission began an
inquiry into Cole National Corporation's previous accounting.
The Company has been named as a defendant, along with numerous other
retail companies, in patent infringement litigation in the United States
District Court for the District of Arizona, known as Lemelson Medical, Education
& Research Foundation, Limited Partnerships v. CompUSA, Inc. et al., No. Civ.
00-0663, which challenges the defendants' use of bar code technology in their
retail operations. The Company is participating in a common defense with a
number of other defendants. A stay of the proceedings has been sought and was
granted, in deference to prior pending declaratory judgment suits brought by the
manufacturers and suppliers of the implicated technology seeking to declare the
patents in suit not infringed, invalid and unenforceable. The Company likewise
intends to oppose the allegations and claims against it.
See Note 7 of Notes to Consolidated Financial Statements for further
discussion of these legal proceedings.
26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits. The following Exhibits are filed herewith and made a part
hereof:
99.1 Certification of Chief Executive Officer and Chief Financial
Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
The Company filed a Form 8-K (Item 5) on December 6, 2002
announcing that Ron Eilers, President and Chief Operating Officer
of Deluxe Corporation (NYSE:DLX), had been appointed to its Board
of Directors.
The Company filed a Form 8-K (Item 5) on August 9, 2002, which
attached a press release announcing the extension of its offer to
exchange its 8-7/8% Senior Subordinated Notes due 2012 for its
existing 8-7/8% Senior Subordinated Notes due 2012.
The Company filed a Form 8-K (Item 5) on November 26, 2002,
which attached a press release announcing that the Company
determined to restate its previously issued financial statements
for the timing of the recognition of revenues earned on the sale
of extended warranty contracts.
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
COLE NATIONAL GROUP, INC.
By:/s/ Lawrence E. Hyatt
------------------------------------------------
Lawrence E. Hyatt
Executive Vice President and Chief
Financial Officer (Duly Authorized Officer)
By: /s/ Ann M. Holt
-----------------------------------------------
Ann M. Holt
Senior Vice President and Corporate Controller
(Principal Accounting Officer)
Date: May 16, 2003
28
CERTIFICATION
I, Jeffrey A. Cole, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Cole National Group,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 16, 2003
/s/ Jeffrey A. Cole
--------------------------------------------
Jeffrey A. Cole
Chairman and CEO
29
CERTIFICATION
I, Lawrence E. Hyatt, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Cole National Group,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 16, 2003
/s/ Lawrence E. Hyatt
-----------------------------------------------------
Lawrence E. Hyatt
Executive Vice President and Chief Financial Officer
30
COLE NATIONAL GROUP, INC.
FORM 10-Q
QUARTER ENDED NOVEMBER 2, 2002
EXHIBIT INDEX
Exhibit
Number Description
99.1+ Certification of Chief Executive Officer and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
+ Filed herewith.
31